Interest-Rate Drop Is Called A 'Positive Step' Fed Cut in Discount Rate This Week Is Aimed at Encouraging Consumers, Banks, to Spend. FEDERAL RESERVE BANK

Article excerpt

THE Federal Reserve can lead bank customers to lower interest
rates, but it can't make them borrow.

That's the reaction of many economists and businessmen to the
Fed's latest cut in its discount rate, which aims to promote
spending in order to accelerate the pace of recovery from the
1990-91 recession.

The rate cut is "a positive step that improves the consumer's
ability to finance new cars. The uncertainty is what kind of effect
that will have on the consumer's willingness," says Terry Sullivan,
a spokesman for General Motors Corporation, which along with the
auto industry as a whole has been starved for sales.

"This will help, but it's not going to be anything dramatic,"
adds Richard Peterson, chief economist at Continental Bank in
Chicago. Concern over the economy is making consumers cautious
about spending, he says.

The discount rate is the interest rate that the Fed charges
member banks for loans. Adjustments to the rate are a strong signal
of monetary policy: downward to stimulate economic growth; upward
to arrest inflation. Banks generally adjust their own interest
rates accordingly.

On Wednesday the Fed set the discount rate at 4.5 percent. That
was the fifth rate reduction since Dec. 17, when it was 7 percent,
and the lowest it's been since 1973. A number of major banks
quickly announced similar cuts.

The initial effect of lower interest rates is smaller repayments
on floating-rate debt. The effect is staggered because interest
rates on corporate borrowings, for instance, might be recalculated
every month while the rates on some mortgages are adjusted only
once a year.

"For {every} person who's paying less interest there's {a}
person who's receiving less interest," notes Steven Strongin, an
economist with the Chicago Fed. But the economy still gets a boost
because a decline in interest income doesn't curtail spending plans
as much as a decline in interest costs stimulates spending by
making debt more affordable.

Individual debtors will use the savings to pay off debts faster,
bank it, or take it shopping.

"That's exactly what the Fed is trying to engineer here," says
Wayne Ayers, chief economist at the Bank of Boston. "Even debt
reduction improves net worth and over time that puts the consumer
in a better position to spend."

Businesses are likely to bank their own interest rate savings
until the extra dollars from consumers begin flowing in. Then they
will consider spending to expand operations. …